Chris Blumas, portfolio manager, Raymond James Investment Counsel 

FOCUS: North American large caps 

MARKET OUTLOOK:

Concerns about inflation have prompted central banks around the world to tighten monetary conditions. However, the pace of tightening has varied among central banks as striking the right balance between supporting growth and managing inflation has proven challenging.

While core inflation in the U.S. is down significantly from its peak, it continues to remain “stubbornly high” and above the U.S. Federal Reserve’s two per cent inflation target. However, downward trends in all three parts of core inflation (core goods, housing services and core services excluding housing) suggest that inflation is likely to continue rolling downward this year. In fact, if we look at annualized core inflation over the last six months (1.8 per cent) and last three months (1.5 per cent), both measures are on target and trending downward. Overall, this is a favourable development for investors and increases the probability of interest rate cuts later this year.

During quantitative tightening (QT), the Fed effectively sells bonds and removes liquidity from the financial system. During its last tightening phase (October 2017 – September 2019), the Fed removed too much liquidity and caused a crisis in the repurchase agreement (repo) market. As a result, it was forced to abruptly end QT and inject liquidity into the financial system. Going forward, this is likely a mistake that the Fed would like to avoid and we will hear more on this subject at the next meeting in March.

With lower interest rates and less QT, the outlook for financial markets is positive. However, a favourable environment can turn unfavourable in a hurry and investors should remain well diversified and defensively positioned. There are pockets of value in today’s markets and history has shown that the single biggest mistake an investor can make is to exit the markets at the wrong time.

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TOP PICKS:

Brookfield Infrastructure Partners (BIP.UN TSX)

Brookfield Infrastructure Partners is a global infrastructure company with a diversified portfolio of assets. It operates through the following segments, utilities, transport, midstream, and data. The utilities and transport businesses are the most significant and accounted for around two-thirds of cash flows last year. BIP’s size, sponsor support, diversified operating model, and global platform are unique and allow the company to recycle capital opportunistically and grow cash flows at an above-average rate. The shares currently trade around nine times funds from operations and have a dividend yield of 5.0 per cent.

Yum China (YUMC NYSE)

Yum China is the largest restaurant operator in China. The company generates revenues through company-owned restaurants and from franchise fees. Yum China’s most well-known brands are KFC, Taco Bell, and Pizza Hut but its restaurant portfolio also includes several other well-known local brands and concepts. While some near-term headwinds associated with macroeconomic conditions persist, the company’s resilient business model, proven management team, and strong digital capabilities should allow it to continue growing sales and profits at an above-average rate. The company has an exceptionally strong balance sheet (net cash of almost $2.5 billion or $6 per share) and a loyalty program with over 400 million members. The shares currently trade at around 16 times adjusted forward earnings and have an adjusted free cash flow yield of more than 5.0 per cent.

RTX (RTX NYSE)

Raytheon is an aerospace and defence company with a global presence. The company was created a few years back with the combination of United Technologies aerospace business and legacy Raytheon. The combined company has a unique business model because of the relative balance between the aerospace and defence businesses. Overall, this gives Raytheon greater cash flow stability and the ability to operate in a more counter-cyclical manner. The company also has a strong management team and is very shareholder-friendly. Raytheon is currently dealing with a powdered metal issue in its jet engine business. This issue didn’t impact cash flows last year but is expected to reduce cash flows over the next few years. Going forward, I think that the company has the financial strength to deal with these added service costs and continue to execute its strategic plan. The shares currently trade around 17 times forward earnings and have a trailing free cash flow yield of almost 4.5 per cent.

PAST PICKS FEBRUARY 15, 2023

Algonquin Power (AQN TSX)

• Then: $10.19
• Now: $7.86
• Return: -23%
• Total Return: -18%

Walt Disney (DIS NYSE)

• Then: US$109.24
• Now: US$110.33
• Return: 1%
• Total Return: 1%

CVS Health (CVS NYSE)

• Then: US$88.35
• Now: US$76.73
• Return: -13%
• Total Return: -10%

Total Return Average: -9%